What Is Value Investing?

What is Value Investing? It is basically a set of tenets introduced by Graham when he wrote Security Analysis in 1934. Fundamentally, value investing involves buying stocks that are out-of-favor in the market due to investor irrationality. This irrationality, in the extreme, can often push a stock’s price well below its true value. A shrewd value investor seeks to determine the true value of such stocks, thus taking advantage of this type of investor irrationality.

The track records of some of the world’s most successful value investors demonstrate the effectiveness of the value investing philosophy. Among such investors are: Warren Buffett, Charlie Munger, Walter Schloss, William J. Ruane, Irving Kahn, Charles Brandes, Mario Gabelli, Bruce Greenwald, Seth Klarman, John Templeman, Joel Greenblatt, Martin J. Whitman, and Max Heine – many of whom have followed Graham in their investment principles. As Buffett once said, “Follow Graham, and you will profit from folly rather than participate in it.”

There are several key principles and concepts that underpin the value investing mindset and are central to the philospohy espoused by Graham. Two principles in particular stand out: firstly, the value investor always takes take a business owner’s prespective when analyzing a company. Secondly, the value investor always counts on the irrationality of the markets in the short term (Mr. Market). Once these two principles are established during the evaluation of an out-of-favor stock for purchase, the value investor must follow the additional principles of determining intrinsic value and a margin of safety.

In short, the key principles are:

Approach the stock valuation from a business owner’s perspective. Imagine you already own the business – you will if you buy the stock, as a single share of stock is a de facto ownership slice of the issuing company

Establish that the market has irrationally beaten down the stock’s price, and the price bears no relation to the stock’s actual worth or net asset value. They should be as far removed from one another as possible.

Determine the stock’s intrinsic value, which can be a wide range, and is usually an estimate because the calculation of intrinsic value is not by any means an exact science.

Determine the margin of safety – in other words, is the stock sufficiently undervalued to weather any uncertainty or market downturns – and decide whether all the evidence points to a worthwhile investment.

We’ll cover the principles of value investing in greater detail in this series.